Audit Committees

• Author: Louis Braiotta,
• Pages: 39-42

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Audit committees are a key institution in the context of corporate governance. They ensure that boards of directors fulfill their financial and fiduciary responsibilities to shareholders. Through their audit committees, boards of directors establish a direct line of communication with internal and external auditors as well as with the chief financial officer of the entity. Such an organizational structure combined with reporting responsibility in an environment of free and unrestricted access enables full boards of directors not only to gain assurance about the quality of financial reporting and audit processes, but also to approve significant accounting policy decisions. Moreover, strong and effective audit committees, through their planning, reviewing, and monitoring activities, can recognize potential problem areas and take corrective action before problems that affect companies' financial statements and other financial disclosures arise. Thus, audit

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committees have an important role in helping boards of directors avoid litigation risk because such committees provide due diligence related to financial reporting.

REQUIREMENT FOR AUDIT COMMITTEES

Audit committees have long been seen as an important group in ensuring greater corporate accountability in the United States. The value of such committees has been noted by the U.S. Congress, the U.S. Securities and Exchange Commission (SEC), the New York Stock Exchange (NYSE), and the American Institute of Certified Public Accountants. Audit committees are required by the NYSE, American Stock Exchange (AMEX), and National Association of Securities Dealers (NASDAQ/National Market System issuers).

Prior to changes imposed by the passage of the Sarbanes-Oxley Act of 2002, other major efforts were directed at the betterment of audit committees. One such effort was the publication of the Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees in 1999. There followed, in the same year, new rules and disclosures related to audit committees by the NYSE, NASDAQ, and AMEX.

Notwithstanding earlier events, in 2001 with the disclosure of a number of major accounting scandals (e.g., Enron and WorldCom), questions were raised about the effectiveness of audit committees. As a result, the U.S. Congress passed the Sarbanes-Oxley Act and the SEC adopted final rules amending the securities laws. Such actions have had an impact on audit committees. In response, the self-regulatory organizations (such as NYSE, AMEX, and NASDAQ) enacted amendments to their listing standards with respect to the role and responsibilities of audit committees within the corporate governance framework. Hence, the major thrust of these reforms is to create a new legal and...